What is Refinancing ?
Refinancing refers to the replacement of an existing debt obligation with a debt obligation bearing different terms. The most common consumer refinancing is for a home mortgage.
Advantages of Refinancing..
Refinancing may be undertaken to reduce interest rate/interest costs (by refinancing at a lower rate), to extend the repayment time, to pay off other debt(s), to reduce one's periodic payment obligations (sometimes by taking a longer-term loan), to reduce or alter risk (such as by refinancing from a variable-rate to a fixed-rate loan), and/or to raise cash for investment, consumption, or the payment of a dividend.
In essence, refinancing can alter the monthly payments owed on the loan either by changing the loan's interest rate, or by altering the term to maturity of the loan. More favorable lending conditions may reduce overall borrowing costs. Refinancing is used in most cases to improve overall cash flow.
Another use of refinancing is to reduce the risk associated with an existing loan. Interest rates on adjustable-rate loans and mortgages shift up and down based on the movements of the various indices used to calculate them. By refinancing an adjustable-rate mortgage into a fixed-rate one, the risk of interest rates increasing dramatically is removed, thus ensuring a steady interest rate over time. This flexibility comes at a price as lenders typically charge a risk premium for fixed rate loans.
In the context of personal (as opposed to corporate) finance, refinancing a loan or a series of debts can assist in paying off high-interest debt such as credit card debt, with lower-interest debt such as that of a fixed-rate home mortgage. This can allow a lender to reduce borrowing costs by more closely aligning the cost of borrowing with the general creditworthiness and collateral security available from the borrower. For home mortgages, in the United States, there may be certain tax advantages available with refinancing, particularly if one does not pay alternative minimum tax
Most fixed-term debt contains penalty clauses (known as "call provisions") that are triggered by an early payment of the loan, either in its entirety or a specified portion. In addition, there are also closing and transaction fees typically associated with refinancing debt. In some cases, these fees may outweigh any savings generated through refinancing the loan itself. Typically, one only rationally considers refinancing if the potential for a substantial cost savings exists, or if there is a need to extend the loan due to weak cash flow or other non-recurring commitments.
In addition, some refinanced loans, while having lower initial payments, may result in larger total interest costs over the life of the loan, or expose the borrower to greater risks than the existing loan, depending on the type of loan used to refinance the existing debt. Calculating the up-front, ongoing, and potentially variable costs of refinancing is an important part of the decision on whether or not to refinance.
Types Of RefinancingNo Closing Cost
Borrowers with this type of refinancing typically pay few upfront fees to get the new mortgage loan. In fact, as long as the prevailing market rate is lower than your existing rate by 1.5 percentage point or more, it is financially beneficial to refinance because there is little or no cost in doing so.
However, what most lenders fail to disclose is that the money you save upfront is being collected on the back through what's called yield spread premium (YSP). Yield spread premiums are the cash that a mortgage company receives for steering a borrower into a home loan with a higher interest rate. The latter will even eventually lead to borrower's overpaying.
Cash Out
This type of refinance may not help lower the monthly payment or shorten mortgage periods. It can be used for home improvement, credit card and other debt consolidation if the borrower qualifies with their current home equity; they can refinance with a loan amount larger than their current mortgage and keep the cash difference.